Asset Valuation, Income Determination and Changing Prices.

Abstract The article reports that in the October, 1971 issue of "The Accounting Review," professor Harold Bierman presented a discussion of a situation in which the application of general price-level adjustments to basic historical cost data results in an adjusted historical cost number which is significantly different from "value." "Value" for purposes of the Bierman discussion is estimated using discounted cash flow analysis. Bierman examined two cases. In the first case, the company incorrectly forecasts changes in the general price level and subsequently determines that increases in the general price level have occurred and are anticipated to occur in the future. In the second case, the company correctly anticipates movements in the general price level and adjusts its acceptable rate of return criterion accordingly. In both, Bierman assumes that cash flows from the project under analysis are "perfectly positively" correlated with movements in the general price level. Bierman's analysis uses discounted cash flow and annuity depreciation methods. He demonstrates that a difference exists in the net value of an asset when the investor ignores price-level change in the estimate of cash flows and the discount rate, and when he properly estimates the effect on both variables.